State v. Market

The last century has witnessed an enormous tug-of-war between the state and the market. One hundred years ago, coming out of World War I, three successive Republican administrations in the United States embraced the laissez-faire principle of limited government involvement in the market, a view that found considerable resonance among classical liberal economists and politicians in Europe. In the inter-war period, the state came back in vogue as the engine of economic transformation for movements with widely divergent political philosophies: Communists, Fascists, and New Dealers. After World War II, it looked as though, in the social welfare states of Europe, the military-industrial complex and Great Society efforts in the United States, and the state-led planning in the Communist world, the tug of war had effectively dragged the laissez-faire crowd into the mud.

But the game was not over. The free marketeers dug in their heels. In the late 1970s, the flag started to inch in the other direction, first under Margaret Thatcher in England and then more dramatically during the 1980s under Ronald Reagan in the United States. Their mantra of TINA — There Is No Alternative – suggested that countries all around the world had no choice but to reduce the size of government services (except the military), privatize state assets, and dismantle regulatory structures. This “neo-liberalism,” which pushed for the least amount of state involvement in the economy, spread worldwide as the central gospel of globalization, a process urged on by international institutions such as the International Monetary Fund.

In some ways, the political events of 1989 in Eastern Europe were simply one more inevitable pull in the tug-of-war contest that the free marketeers were clearly winning at that point. One after another, after the dust from those initial protests and regime resignations dissipated, the countries in the region followed a similar template of change. They whittled away at the state and brought in the free market literally overnight.

Bulgaria was no exception. “In general, they suggested quick privatization and no role for the state to play in the economy,” recalls Rossitsa Chobanova, an economist who specializes in innovation. “The economists here proposed measures for transforming a command economy into a market economy that respected specific Bulgarian characteristics, such as allowing a variety of forms of ownership dominated by private ones, and the need to renovate in order to be competitive in a globalized world. And now we are in a period when everyone realizes, even in big and powerful economies like the United States, that it’s not possible to meet the contemporary challenges of globalization and rapid technology change by ignoring the role of the state.”

One role the state has stepped back from has been investments in research and development (R & D). “The state policy stimulated innovations – ‘scientific and technological progress’ was the phrase we used at that time,” Chobanova continued. “The country, mainly the state, invested 2.8% of the GDP into spending for science and technological development in 1986 (compared to the Europe 2020 target of 3%). Most of that spending was for business renovation. At that time 37 state institutes were responsible for developing new technologies and products for state business enterprises in industry.” That figure of R & D investment subsequently dropped to 0.6 percent.

In her office at the Bulgarian Academy of Sciences, located just across from the Parliament, we talked about the reasons behind the collapse of the Bulgarian economy, the current lack of market demand in the country, and why so many computer viruses in the early 1990s came from Bulgaria.

The Interview

Do you remember where you were when you heard about the fall of the Berlin Wall? And do you remember how you felt, and do you remember whether you thought about the implications for Bulgaria?

I do remember. I was at the Institute of Economics at the Bulgarian Academy of Sciences. My colleagues and I talked about how it would be good that the people in Germany will live together again, but we wondered how the social and economic differences would be overcome, and agreed that it would not be easy. .

It was clear that there would soon be political implications for Bulgaria, but it was not clear what the consequences would be for the national economy and society as such. Like the majority of the people in the country, I had an idealistic view that, with democracy, we would reach a better living standard. I thought that open borders, the possibility to travel and to share experience, to work in other places, to study in different places would contribute to the open circulation of knowledge accompanied by better use of resources and improving wellbeing of the population

It was not an easy task, and no one was prepared to solve this task. There were some predictions that the transformation would take place in two or three years, or five to 10 years, during which the economy could decline. It was strange how quickly the unification of Germany took place. I talked about it with an advisor to the German (FRG) foreign minister (I knew him from Helsinki Citizens Assembly). He told me, “We had a plan for a very smooth unification for two years. But because of political pressure, the unification took place in six months. And that’s why a lot of problems appeared.” He was very unhappy about the unfair approach to solving social problems that accompanied the transformation of Eastern Germany and the unification of Germany.

Here I have to be clear that in general the intellectual elite in Bulgaria realized the need for change. Along with this, a lot of demonstrations took place in the country—you know about this. People understood that it was not possible to continue in the same way and wanted something different, but with no clear understanding of how it could happen specifically. Starting the transition with no clear concept of how to achieve a better life and a stable, competitive economy under the new conditions of globalization, the Bulgarian economy lost a lot of its power.

Currently we are one of the most financially stable countries, but with a weak economy. Bulgaria is in the group of European countries with the lowest level of wages, productivity and innovativeness.

What did you think about the early discussions about economic change in Bulgaria, in 1989-1990? How would you evaluate those early discussions about economic change?

The necessity of change in the society, and in the economy in particular, appeared in several works of philosophers and economists in the country before and after 1989. The economic topics concerned barriers to innovative entrepreneurship and forms of property. The problem of the implementation of new technologies had two sides. One was to exit from the list of COCOM (the Coordinating Committee for Multilateral Export Controls), which the Western powers established during the Cold War to put an arms embargo on COMECON (the Council of Mutual Economic Development). And the other was to increase the effectiveness of investments in new technologies in order to improve the competitiveness of the national and regional economy. The question was what to do in order to make new technologies attractive for investors.

Before 1989, the country had only one investor – the state. In this respect we worked to improve the normative base – the operating instructions — for defining which investments were effective. But each new technology needs different instructions. How to proceed? What to do in order not to lose the momentum for renovation? The new instructions took too long time to be implemented. In comparison with firms in Western countries, it was not so easy for Bulgarian firms to compete. Many state regulations hampered innovative entrepreneurship. The conclusion, ultimately, was that something more general in society had to be changed. The ideas and suggested measures were published. The state regulations were published in early December 1988, but they demonstrated ideas were not well enough understood by the officials. So these recommendations had little impact.

Discussions about ownership concerned the introduction of various forms of ownership, as well as mechanisms of privatization and restitution, were also published in thematic collections. We had interesting suggestions. But they were not used by our government. Even when two colleagues from my department became ministers (of economy and of social affairs) they ignored the local expertise. They preferred foreign experts who were familiar only with the big Soviet economy and didn’t know the specifics of a small and open economy like Bulgaria.

What were the main differences between what economists here were proposing and what foreign economists were proposing?

I suppose you mean the main difference with the program of the foreign economists, especially Richard Rahn and Ronald Utt, whose ideas were implemented during the transformation of the national economy. In general, they suggested quick privatization and no role for the state to play in the economy. The economists here proposed measures for transforming a command economy into a market economy that respected specific Bulgarian characteristics, such as allowing a variety of forms of ownership dominated by private ones, and the need to renovate in order to be competitive in a globalized world. And now we are in a period when everyone realizes, even in big and powerful economies like the United States, that it’s not possible to meet the contemporary challenges of globalization and rapid technology change by ignoring the role of the state.

Has there been any change in the perspective of the Bulgarian government in terms of the role of the state?

Practically there have been no changes in the perspective of the Bulgarian government in terms of the role of the state. In the beginning of the transformation, this perspective was grounded in the state’s heavy involvement in the economy and the necessity to transform the command economy into a democratically organized society. As I mentioned before, some of these regulations created barriers to innovative entrepreneurship. But not everything from the policy before 1989 had to be neglected. For example, the state policy stimulated innovations — “scientific and technological progress” was the phrase we used at that time. The country, mainly the state, invested 2.8% of the GDP into spending for science and technological development in 1986 (compared to the Europe 2020 target of 3%). Most of that spending was for business renovation. At that time 37 state institutes were responsible for developing new technologies and products for state business enterprises in industry.

But after that, it wasn’t just that we had a lack of a concept, there was also the collapse of the COMECON market. COMECON was a main market for the Bulgarian producers. We lost our main foreign markets and that was the mean reason for the collapse of our big enterprises and research institutes. It’s not easy when you are a small country and a small economy: you are more dependent on outside countries and processes. In this situation the state had to take an active position, but it didn’t. Decreased foreign demand for Bulgarian products accompanied the collapse of the COMECOM market, leading to a reduction in demand for their renovation. Many opportunities for good workplaces were lost. The intelligent young people, who are educated here, could not find appropriate jobs in the country and went to find jobs somewhere outside. Even my older daughter is now working in Washington D.C. as a consultant. Along with the lack of internal market demand for higher educated personnel, a lot of people are leaving the country because of the very low level of the salaries. It is not easy to survive when prices are going up. They’re now more or less equal to average European prices, and the salaries are three or more times less than the EU average.

The lack of state policy during the transition also negatively affected demographic trends in the country. The aging of the population has combined with a low birthrate and this emigration. Many people have been afraid to have kids because of the difficult economic situation. In conclusion, I’d say that it’s time to stop neglecting the role of the state in the economy.

Tell me how you got involved in the Helsinki Citizens’ Assembly (HCA). Because that’s where I met you initially.

In 1990 I learned about the International University Center in Dubrovnik and one of their seminars on the political economy of self-management. I applied for and received a small grant to attend this seminar. There presenting and discussing some results of my work, I met very interesting people. Together we developed an international institute for self-management, which is based in Frankfurt. And through these colleagues I heard about founding HCA gathering in Prague.

My HCA experience included two mandates as the convener of the Economy & Ecology Commission. I met people from different countries and found out about different ways of thinking, different values. It was important to discover that even though there are very different approaches to solving problems, there are a lot of good, committed people as well.

And you had a national committee here in Bulgaria?

Yes.

How long did that last?

Until 1996-7. In the beginning it was very active and powerful. But then it practically became less and less important, from my point of view. Vaclav Havel was one of the people who founded HCA, and there were a lot of good ideas for the unification of Europe and better understanding in different countries.. But after five or six years, HCA and its national committees were no longer as important as before.

How do you feel overall about the Bulgarian economy today?

From the financial point of view, it is stable enough, but there are also some imbalances in the economy. In terms of financial stability, Bulgaria has followed EU requirements for macroeconomic stability. It had a budget deficit of only 0.5% in 2012, which is quite below the EU target of 3%. This stability has been achieved on the basis of very low salaries, even lower than Greece, which could lead to social protests. I don’t think that it’s possible to have the same development here as in Greece and Spain. Bulgaria doesn’t have a deficit like in Greece. This stability attracts people from Greece to develop their businesses here, which is not bad. From the point of view of developing international economic relations and attracting foreign investors, the strict financial regulations of the currency board are very good, because Bulgaria is a stable partner. On the other hand, more internal imbalances in the economy have appeared, resulting in low levels of income, higher levels of prices (close to those in the most European countries), and a brain drain

And also the economy is not growing very quickly, is it?

The economy is growing, but not very quickly. This takes into account the drastic fall that took place in the 1990s. According to some calculations we are still below the level of 1989 or at the same level.

And do you think a major reason is because of this rather strict fiscal discipline or the transformation and collapse of the previous system?

I don’t think that fiscal discipline is the main reason that the economy not growing very quickly. In fact, from the point of view of the global economy, this fiscal discipline attracts foreign investment. The collapse of the previous system and transformation are not reasons either since these processes were completed by the end of the last century.

So what do you think is the major reason why the Bulgarian economy is either slightly below the 1989 level or at the same level?

The reason is very simply: the lack of market demand.

For Bulgarian products?

For Bulgarian products both inside and outside the country. We lost our foreign markets. And domestically, because of the low level of salaries and pensions, the people are not able to consume very much. We need new markets for our products. Now the main foreign market is the European Union. It’s not realistic to enlarge this market because of the current crisis.

Has there been sufficient innovation at the level of firms to produce new products?

There hasn’t been sufficient innovation at the level of the firm. Bulgaria’s business enterprise research and development expenditure (BERD) is now 116.93 million Euros (2011), far behind the EU average. This level is very low compared to the past as well.

As I told you, the state firms, the major innovators in this country, were destroyed because of the loss of their markets. During the period 1990-1997, when the privatization and the loss of former foreign markets took place, the separate research organizations funded by the ministry of economy and working for state-owned big business complexes — as well as R&D offices inside business enterprises — were closed. During this period business R&D expenditures were decreased from more than 90% to about 20% of total. This change has affected the whole Bulgarian innovation system up to now.

The recent industrial structure, dominated by a majority of small and medium-sized business enterprises, does not encourage big innovations.

You mentioned that before the government provided 2.8% of GDP for innovation—

I mentioned that the Gross Research and Development Expenditure (GERD) was 2.8% of GDP. In the last decade, however, the country’s GERD has remained at a low level. The data for the 2010 shows R&D expenditures of 0.6% of GDP, and 0.57 % for 2011. The level of R&D expenditures as a share of GDP is almost 4 times lower than the EU-27 average, estimated by Eurostat for 2011 as 2.03%. The results of my work show that one way for business enterprises to overcome the industrial structure’s barriers to innovation is to become more actively involved in international supply chains as well as in innovative networks and clusters, leaving some added value in the country.

So, for instance, agro-processing. McDonald’s, for instance, has a major European supply chain, needs potatoes for its French fries, needs tomatoes for its hamburgers. I know that it uses potatoes from Ireland. I don’t know where it outsources, but it has a major supply chain throughout Europe, for its restaurants in Europe. Does Bulgaria participate in that supply chain?

We have McDonald’s like elsewhere. We still have some good industries and possibilities to develop competitive advantages in some areas.

What about EU money through the accession funds, for instance? Has there been, in your opinion, a successful use of European resources?

Now that we’re a member of the European Union, we have access to some funds. There is some success in using European resources during the current programming period. But it is not very easy. We’re not able to use 100% of available resources..

That’s what I understand, that there’s a lack of capacity here to use all of the money that’s available.

The lack of capacity is one reason, but it is not the only one. Too many regulations – EU and domestic — are another very important reason. In this respect I have a question for you. You’re working on the policy side. Do you think that if people, as entrepreneurs or as policy makers, follow all the regulations, they will produce the best policy?

No.

I also think this is the right answer. I had experience with the administrative regulations of a project, that successfully completed its activities and achieved results. But there were administrative problems because of a delay in response from the ministry. I faced a dilemma. What should I do: take the risk or wait for the answer and not finish the project on time? There are too many administrative regulations – common European and domestic — for executing such projects. But at the same time it is necessary to have regulations for using public money. The problem is how to simplify the administration and yet direct the money to activities that could provide a comparative advantage and improve the competitiveness of the national economy.

One of the lessons of South Korean economic development is to break the rules. To a certain extent Bulgaria is in the same situation as South Korea was in the 1960s. In other words, South Korea was regionally at the bottom, compared to Japan, or Taiwan, or Hong Kong. And it had to close the gap, in the same way that Bulgaria has to close the gap between itself and the rest of Europe. And South Korea could have followed the rules, but it didn’t. It actually broke the rules. So, for instance, one of the rules is that you figure out what your comparative advantage is and you invest in your comparative advantage and you succeed. Except that didn’t work for South Korea, because its comparative advantage was cheap labor and cheap products. But that didn’t improve Korea’s position vis a vis Japan. So, the state invested into firms that produce things that were not Korea’s comparative advantage such as shipbuilding. Korea had no shipbuilding industry, but it saw that it could compete against the leading shipbuilding of the world because of low labor costs, because it could put resources into the latest technology. And against all the advice of international experts and economists, they invested into shipbuilding. And became the top shipbuilders in the world.

Who advised them to do this?

This was entirely a national decision. There were no international experts who recommended this path.

Korea had resources.

Actually they didn’t have resources. South Korea has no energy resources. It had to import much of the material to produce the steel. The only thing they had was water, but they decided that it was critically important to have steel for all the other industries they planned to develop with the steel: shipbuilding, automobiles, trains. So they broke the rules, they invested in these enterprises.

They had priorities.

Yes, they established certain strategic priorities.

This means that they had a technology policy.

But Bulgaria doesn’t have that?

It does. The National Strategy of Scientific Research to 2020 (adopted by the Parliament in 2011) listed five priority areas: energy, energy efficiency and transport; development of green and eco-technologies; biotechnologies and bio-foods; new materials and technologies; cultural and historical heritage. The information and communication technologies (ICT) have been listed as a horizontal topic. We have a good history of information technology. Here’s an interesting story. In the early 1990s, when the drastic decline of the IT sector in the country became a fact, 120 of 140 of the most dangerous computer viruses were produced by IT specialists in Bulgaria.

Why did they produce the viruses?

One of the areas of specializations of the country in the frame of the COMECON market was the ICT sector. The production of viruses happened when this sector, employing mainly young people, was sharply affected by the loss of the COMECON market. The production of viruses was a reaction to the unemployment crisis. The story had a “happy” end. When the big foreign companies in the sector figured out who created those viruses, they invited the “inventors” to work for them. After that, most of these computer specialists are now working abroad, and are no longer producing viruses.

What is the IT industry today in Bulgaria producing for the most part?

Software.

For the international market or just Bulgaria?

The IT sector is producing for both national and foreign markets, but predominantly for international markets. For example, some of the institutes here at the Bulgarian Academy of Sciences are producing software for the United States, for NATO. An important problem with this industry is that the exporters often didn’t receive intellectual property rights for what they were selling. Another problem concerns the sellers of software products abroad not paying taxes to the state. The ICT sector is important for all other technologies’ development, and in this respect it is the main engine for economic change and competitive development under globalization.

I think that you’re in the right field.

Yes, but on the other hand, globalization and rapid technological change are the reasons for the technology gap between countries on the technological frontier and the rest of the world. And we are unfortunately are on the wrong side of the gap. Something has to be done by the state on international level to make this gap smaller and avoid “inventors’” resistance.

When you think back to 1989, and you think about all that has changed between 1989 and today, how would evaluate that on a scale from 1 to 10, with 1 being most disappointed and 10 being least disappointed.

4.

The second question is when you think back to 1989, and consider everything that has happened since 1989 till today, how do you feel about your own personal life, with 1 being most dissatisfied and 10 being most satisfied?

7 or 8.

The third and last question is, when you look into the future, into the next 1 or 2 years, and you think about where Bulgaria will be in the near future—again according to a scale form 1 to 10—how do you feel with 1 being most pessimistic and 10 being most optimistic?

3 or 4.

Sofia, September 26, 2012

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3 Comments

Yes, obviously it’s time to stop neglecting the role of the state in the economy.
But I think that here is neglected the most important act what influenced the whole period of transformation:
The privatization of all financial resources of the Bulgarian State by the former communists caused the state owned firms to collapse. The lost of foreign markets was the consequence.
So after 23 years of “transformations” the renovated Communist party is still in power in Bulgaria. Now the young Bulgarian people are protesting against the mafia of politicians, state administrators of all kind and even prosecutors, shouting “Red Junks”.

Yes, the privatization process was an extraordinary transfer of wealth to a relatively small minority of people. In most cases, the old political elite relied on their insider knowledge to become the new economic elite.

It was easy predictable that the specific skills that would form these new elite /born by criminal privatization/ would harm badly the Bulgarian society. For 23 years the Bulgarians reduced with 2 millions and the transformation to capitalism become economical genocide.
It was also easy predictable that this will keep the price of land very low for a long period of time.